Obama Wants Higher Capital Gains Tax Rate: Too Far Or Not Enough?

In his efforts to find revenue streams to fund domestic priorities and close the deficit, President Barack Obama introduced, as part of his budget proposal, a variety of tax revisions and increases on Wall Street and the wealthiest of Americans.

The president wants to roll back the Bush tax cuts on the affluent, reinstating the 36 percent and 39.6 percent rates for those earning more than $250,000 (married) and $200,000 (single). He also called for a reinstatement of the "personal exemption phaseout" and limitation on the deductions applied to taxpayers earning more than the aforementioned incomes.

But on the topic of the capital gains tax, Obama seemed to try and thread the needle, introducing a mild increase over the rates of the Bush years that could anger (or please) both Wall Street and more progressive-minded economists alike.

The president's plan would raise the tax rate on capital gains and dividends to 20 percent from the 15 percent levels imposed by the Bush administration. In a climate in which few people are actually making capital gains earnings, raising the rate, economists say, shouldn't dry up market activity much, if any. On the flip side, the Obama budget team projects that it could help decrease the deficit by more than $1 billion in fiscal year 2010, $5.4 billion in 2011, $12.2 billion in 2014 and $19.9 billion in 2019.

"This increase will not just have no severe effect on the economy but have almost no effect except higher revenues," said Robert Shapiro, the deputy commerce secretary under Bill Clinton and an occasional adviser to president's economic staff. "It is basically a freebie. So why not do it?"

But expect Wall Street (and supply-side theorists) to protest. Capital gains tax rates were higher than 20 percent until lowered to that level during the Clinton years. And because the subsequent boom of the stock market is often credited to the lowering of that rate -- as well as Bush's further lowering -- it is assumed that the restoration of the 20 percent rate would lead to a big blow on the markets.

Others contend that this is a false rendering of history. The Center on Budget and Policy Priorities -- citing a study by Federal Reserve economists -- argues that, "the stock market increase was not a result of the 2003 tax cut. European stocks, which did not benefit from the U.S. capital gains tax cut, performed as well as stocks in the U.S. market in the period following the tax cut."

Moreover, it is noted, the Obama administration could have actually lost revenue had they left the rates where they currently are. The Congressional Budget estimated that extending the 15 percent capital gains tax rates over the next decade would have cost the government $100 billion.

But if raising the rates to 20 percent could, as Shapiro posits, result in an increase in revenue without noticeable market activity loss, why, some may ask, doesn't Obama go even further. For starters, Shapiro replies, once you go too high, you will see legitimate market reaction. But mainly, it would require a much more fundamental reconsideration of tax law, that isn't suited to come via a budget.

"When you begin to bring the capital gains rate near the top marginal rates then you are in a different system and a different set of questions arises," he said. "If we are going to treat capital gains as ordinary income then we need to think about larger reforms. Like ending the tax distinction between earned income and non-earned income...but that is not a budgetary consideration."

In his budget, Obama did take another action on capital gains tax by phasing out the elimination of such taxes for startup and small businesses. But, as pointed out by Ben Smith, the president had promised to do this upon taking office, but the cut was deferred in his budget to 2014.